infrastructure finance - the changing landscape in sa

8/7/2019 Infrastructure Finance - The changing landscape in SA

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March 2010

Infrastructure Finance

The changing landscapein South Africa


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Stimulus packages in many countries, including

South Arica, are being used to redress part o the

inrastructure gap, which in addition to achieving the

short-term goals o creating employment and ostering

spending, should create a good platorm or increased

economic eciencies going orward.

Governments need to look beyond short-term objectives

and articulate a much broader vision or enhancinginrastructure as measured, not just by jobs created, but

by enhanced productive capacity or the uture.

Funding is still a problem in the current constrained

credit environment, and although the stimulus

packages address some o the shortalls, market

conditions are making it hard to und the balance o

required projects in the private debt capital markets.

Budgetary constraints and reduced taxation collections

are impacting the States ability to und large projects

beyond the stimulus packages, which have placed

urther strain on national nances.

As a result, new and innovative Public-Private

Partnership (PPP) structures are needed to make projects

work. This article looks at how to structure a unique

and optimal partnership solution or each project.

The degree o risk sharing between the public and

private sectors needs to be fexible, and optimised on a

case by case basis to ensure that projects can become

a reality.

Synopsis

The political landscape has changed;infrastructure is top of mind and there isrecognition of the large infrastructure

shortfalls locally and around the world.


3/12The changing landscape o inrastructure nance in South Arica 1

Ater decades o neglect, and despite many other

distractions in the global economy, inrastructure has

nally made it to the top o the political agenda, not

only in South Arica, with its new ocus on service

delivery and job creation, but in many other countries as

well. According to a recent survey, 77 percent o senior

global business executives believe that the current level

o public inrastructure is inadequate to support their

companies long-term growth. These executives believe

that over the next ve years, inrastructure will become

a more important actor in determining where theylocate their operations.1

The public has awakened to the consequences o our

neglected roads, bridges, public transport, electricity

grid and other social inrastructure such as hospitals

and schools. The recent wave o service delivery unrest,

Eskoms load-shedding and media exposs o the

countrys crumbling water and sewage treatment

inrastructure, have ensured that inrastructure delivery

remains top o mind. This is not purely a South Arican

phenomenon. According to a recent poll, 94 percent o

Americans are concerned about the condition o their

countrys inrastructure.2

Thanks to the stimulus packages unveiled in many

countries (see table 1), public inrastructure is receiving

long overdue attention and a signicant inusion o

public unds. While these are welcomed developments,

the level o direct government unding proposed will

meet only a tiny raction o inrastructure needs. In

the United States, according to the American Society

o Civil Engineers, there is a $2.2 trillion gap between

the supply and demand or roads, bridges, water and

sewage systems, public transit systems and other public

inrastructure.3

The inrastructure stimulus money romthe 2009 American Recovery and Reinvestment Act

(ARRA) addresses less than 5 percent o this need.

The current confuence o events presents government

leaders with a unique opportunity to make a timely

and economically productive down-payment towards

closing the global inrastructure gap. Funding

is however, not the only challenge. The current

inadequate state o certain inrastructure demands

innovative thinking in order to speed its improvement.

This means using the ull complement o innovative

inrastructure nancing and delivery solutions available,

while developing new approaches to address todays

challenging market conditions.

The landscape or public and private inrastructure

nancing has changed dramatically since the nancial

crisis began (see table 2). Tightened credit markets

pose as an obstacle to raising debt nance or public

and private inrastructure delivery models. This depends

on high levels o up-ront capital repaid over the long

term through user ees or general taxation. Just as

governments are strapped or cash, private rms ace

diculty raising capital in constricted nancial markets.

However, this does not mean that private involvementis o the table. Governments can make limited public

unds go urther by leveraging the $180 bil lion in private

equity that has been raised by inrastructure unds over

the past ew years.

Introduction

Table 1 Stimulus packages announced across the globe

Australia Around AUD 28 billion

Canada CAD 12 billion

China Around USD 438 billion

European Union Around EUR 173 billion

France Upward o EUR 10.5 billion

Germany Around EUR 19 billion

Japan Around JPY 2.6 trillion

India Around USD 33.5 billion

Sweden SEK 1 billion

United Kingdom GBP 3 billion (in capital spending brought orward)

United States Around USD 113 billion


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Table 2 - How the infrastructure landscape has changed in the wake of the credit crisis

Pre-crisis Demand

Limitedpublicmoneyforinfrastructure

Highconstructioncosts

Fiscaldynamicsencouraginggovernmentsto

explore alternative delivery models

Supply

Well-functioningdebtcapitalmarketsand

international project nance loan market

Highlygearedcapitalstructuresandattractive

equity returns

Dominanceofactiveequityinvestorsand

emergence o inrastructure unds

Post-crisis Demand

Infusionofpublicmoneyforinfrastructure

Fallingconstructioncosts

Fiscaldistresssolidifyinginterestinalternative

delivery models

Supply

Challengeddebtcapitalmarkets,butaidedbynew

borrowing instruments

Priceandtenorconstraintsininternationalproject

nance loan market

Variabilityinequityreturns

Impairmentofsomeactiveequityplayers,balanced

by continued growth in inrastructure unds



Inusion o public money or inrastructure

Ater a long period o underinvestment in public

inrastructure, the South Arican Government in 2008

announced a range o inrastructure investment projects

aimed at increasing the productivity o the South Arican

economy and creating much needed employment.

These projects are estimated to total some R785 billion

over three years (see breakdown in table 3).

Investing in public works to stimulate economic activity

is hardly a South Arican phenomenon. The 2009 ARRA

directs substantial public unding to transportation,

energy and IT inrastructure, schools and ederal

building modernisation, among other areas. Around

the world, inrastructure investment has become a

signicant component o a number o the economic

stimulus packages developed to respond to the global

recession. The European Union has committed upward

o $200 billion to inrastructure. Further east, India is

investing around $30 billion in upgrading the countrys

inrastructure, while China has announced that hal o its$585 billion stimulus package will go to inrastructure.

While the sizable infux o government stimulus dollars

will not come anywhere close to eliminating the

inrastructure decit, stimulus unds should certainly

help improve the condition o inrastructure which has

been badly neglected over the past ew decades.

Falling construction costs

As o March 2009, investment spending (which includes

construction) was down 12 percent in the United States,

and over 20 percent in several Asian and Middle East

markets, with worldwide construction activity levels

not expected to return to their 2008 peak until at least

2011. Due to diminished global demand (or both

residential and non-residential construction), commodity

prices have allen globally, and other construction prices

have allen in some jurisdictions. With new stimulus

unds now available or inrastructure, government

leaders can take advantage o lower construction

costs while providing a needed boost to employment.

An estimated $50 million project at Baltimores BWI

Airport, or example, will be built or $8 million less

than originally estimated, partly because o increased

competition among contractors.

According to the BER 2009 Building and Construction

report, the BER South Arican Construction Cost index

ell by 4.3 percent in 2009, the rst annual decline inthe index since its inception in 1962. Industry players

have suggested that Eskom should consider breaking

the earlier contracts or the construction o the planned

Kusile power station, and re-bidding or these at current

lower construction prices, since the original construction

contracts were contracted when global construction

prices were at a peak beore the recession.

On the demand side

Table 3 Large South African infrastructure projects

Power Madupe R102 billion

Kusile R142 billionOther Eskom projects R96 billion

Transport Gautrain R25 billion

Bus Rapid Transit System R25 billion

Gauteng Freeway Improvement Project R11 billion

Durban Harbour Widening R3.2 billion

New locomotives R12 billion

Multi-products pipeline (Dur-JHB) R10 billion

New Durban Int airport R7.4 billion

Extensions to JHB & CT Int airports R14.6 billion

Fuel New Coega renery R102 billion

Water inrastructure LesothoHighlandsPhase2 R7.3 billion

Berg River dam R1.5 billion

Other Stadiums or 2010 R8.4 billion

Other R217.6 billion


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A possible risk is that contractors could adopt a

low-bid strategy and subsequently recoup the

discount through change orders. Governments

should be aware o these risks and develop strategies

to mitigate them through careul staging o capital

programmes and aggressive contract management.

The changing shape o the demand or PPPs

It is too early to tell or certain whether the inusion o

public money will dampen or stimulate governments

demand or PPPs or other creative nancing solutions.

More public subsidy does not necessarily mean less

private capital. In act, it could actually oster the

reverse: better project economics, better credit and

more private capital put to work. I the hundreds

o billions in planned inrastructure spending in the

stimulus packages can be leveraged with private unds,

then stimulus dollars can generate an even more

proound impact on nations economies. There are

many viable options or integrating stimulus unds into

PPP project structures.

In many countries, PPPs have been successully executed

or projects that required public subsidy to be viable. In

these cases, government unding was used to write

down particular project costs (capital and/or operating)

or risk elements either up ront or over the entire project

lie cycle. Such an approach could be used to leverage

stimulus unding.

The South Arican government appears to be making

increasing use o PPPs and other public-private

investment structures to achieve its inrastructure aims.

For example, the N4 highway rom Johannesburg to

Maputo was concessioned, the Gautrain project was

structured as a PPP, Eskom is currently seeking a private

investor to take a stake in the Kusile plant, and there

are tenders out or PPPs across a range o other asset

classes. The PPP website maintained by the PPP unit in

National Treasury, lists 11 PPP projects active in South

Arica as at February 2010. William Dax, who heads the

PPP unit, has said that 25 PPPs with a private investment

value o R13.8 billion have been completed to date and

an additional R29 billion o private capital is committed

to new PPP projects.

In addition to writing down particular project costs,

jurisdictions are increasingly looking or innovative ways

to make projects viable by involving multiple public

sector entities, both within and across jurisdictions.

Public-public-private-partnerships (PPPPs) are startingto emerge as a way to get projects o the ground

by combining multiple levels o public support. For

example, a new energy-rom-waste project being

developed in Staordshire in the United Kingdom is a

collaborative eort o a number o local governments

that are banding together to achieve economies o scale

that will make the project viable.



On the supply side

Tightened credit markets

Financing markets are improving, but they may remain

less attractive than usual or the near term. In this

context, nancing markets include both government

bond markets and the international project nance loan

markets that provide capital or many PPPs. While many

market participants view inrastructure as an attractive

deensive asset class during this recessionary period, the

dynamics o the credit markets, particularly with respect

to the tenor o debt, have moved in the opposite

direction. As a result, deal volume is down. Transactions

that are being executed are taking more time, incurring

higher costs and relying more heavily on ocial unding

rom institutions like the European Investment Bank.

A number o governments are proactively trying to

ensure that the credit crisis does not stall needed

inrastructure projects. The UK government has decided

it is better to provide additional government-backed

debt nance than to delay projects or restructure scores

o scheduled PPP transactions. Toward this end, the UKTreasury announced in February 2009 that it will lend

directly to those Private Finance Initiative (PFI) projects

that cannot on their own raise sucient debt nance

on acceptable terms. Across the EU, the European

Investment Bank has increased lending to ensure that

signicant deals are executed.

Variability in equity returns

In principle, the great variety o PPP structures makes

it dicult to generalise about equity returns in the

inrastructure market. For example, in some PPP

structures, reduced gearing can lead to lower equity

returns. In others, it can have the opposite eect. The

dierence lies in the nature o the revenue supporting

the structure. For example, in availability payment style

structures where debt costs are passed through to a

government payor, equity returns are stable or rising; in

availability payment style structures where revenues are

xed, equity returns are stable or declining.

Potential fight to quality

On the positive side o the equity equation, there is

likely to be an eventual fight to quality, with investors

seeking sound prospects in the inrastructure sector,

particularly i other asset classes remain severely

impaired (see table 4). This is particularly relevant or

pension unds, since long-term inrastructure projects

are a good t or pension und liabil ities. Over thepast several years, billions o dollars have migrated to

inrastructure unds - the total value o which now ar

exceeds the likely equity component o PPP projects in

the pipeline. There are over 10 inrastructure unds and

provincial growth unds active in Southern Arica.

Table 4 - Infrastructure investors

Strategic buyers/concessionaires

Traditionally,operators,developersorcontractorsintheinfrastructuresector

Oftenbenetfromsectoroperationalexpertise,whichenhancesvalueadd

Long-terminvestmentstrategy

Inrastructure

unds

Privateorlistedequityfundsfocusedoninfrastructureinvestments

Strongliquidityawaitinginvestmentopportunities

Lowerequityreturnsthanfornancialsponsors

Typicallylooktotakepartinaconsortium

Medium-tolong-terminvestmentstrategy

Fundsizesaresmallerthanfornancialsponsors

Financial sponsors Privateequityfundswithshorterexitstrategy

Highequityreturns(+20percent)maylimitabilitytobidcompetitively,buthavebeenachievableincertain

opportunities

Normallylookforshort-terminvestmentswithaclearexitstrategy

Typicallylooktotakepartinaconsortium

Fundsizesrangefrom$6billionto$16billion


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Structuring effective PPPsfor infrastructure

With a greater number o priorities (and industries)

competing or public unds in the wake o the credit

crisis, governments are under more pressure than ever

to be creative about how inrastructure needs are met.

I inrastructure gaps are to be narrowed, the traditional

models o nancing and delivering inrastructure must

give way to new, innovative models and a portolio

o hybrid approaches. The structure and nancing

o inrastructure projects involving both the public

and private sectors will need to evolve in response

to changing conditions in the nancial markets. In

countries around the world, we are starting to see the

outlines o what such innovations may entail.

Inearly2009,theFloridaDepartmentofTransportation

entered into a $1.8 billion 35-year concession with a

private consortium, headed by the Spanish rm ACS

Inrastructure Development, to build and operate

highoccupancytolllanesnearFortLauderdale.

The nancing includes more than $200 million in

equity, $750 million in commercial bank debt anda $603 million loan rom the ederal Transportation

Inrastructure Finance and Innovation Act (TIFIA)

programme.4 In this PPP, the Florida Department o

Transportation will set toll rates, retain all revenues

and make availability payments to the private

concessionaire annually out o all o its revenues

(including state appropriations, tax revenues and tolls).

The project is the rst US toll road PPP structured with

perormance based availability payments.

TheUnitedKingdomisinthemidstofthenations

largest-ever school buildings investment programme,with a goal o rebuilding or renewing nearly every

secondary school in England. To realise this ambitious

goal, the central government has created a PPP model

calledLocalEducationPartnership(LEP),aprivate

sector consortium working in ormal partnership with

local authorities and the central government. Certain

LEPprojectsarebeingdeliveredthroughconventional

capital unding and design-build contracts, while

others employ PPP models. The programme is

designed to capture economies o scale in delivery by

bundling multiple acilities into a single procurement.

Otherinnovativestructuresemergingaroundthe

world include combining multiple public authorities

(such as neighbouring local government entities) to

procure a single project or service. The improved

project economics can attract a broader array

o bidders to the procurement, resulting in cost

eciencies or the local authorities.

These projects, each with its own distinct mix o public

and private participation, demonstrate the diversity o

delivery models available today. There is no longer a

binary decision between public and private. In reality,

nearly every public inrastructure project involves a

large degree o private sector participation through the

normal channels o a market economy. Most PPP models

simply represent a way o deepening and/or broadening

the private sectors engagement in delivery in exchange

or sharing in the associated risks and rewards. The

question policymakers need to answer is: What is the

optimal mixture o public and private sector participationin the project to maximise public value?

This is the central question acing inrastructure

policymakers today. And theres no one-size-ts-all

answer or every situation. Most inrastructure

projects are composed o ve elements or which

responsibility must be assigned: design, construction,

service operation, ongoing maintenance and nance.

Theoretically, any o these elements and their related

risks can be allocated to either the public sector or the

private sector. The shape o that allocation determines

the structure o the partnership.



Determining the right mix o public and

private involvement in inrastructure nancing

and delivery

The ollowing three steps should be considered

when determining the right mix o public and private

involvement in inrastructure nancing and delivery.

Step 1: Determine public authority - What am I

allowed to do?

What laws and policies exist regarding the delivery o

inrastructure and the potential involvement o private

nance? Are there political, legal or policy constraints

that would make it dicult to use certain partnership

structures? These questions are among the rst that

need to be answered beore a public sector entity gets

too ar ahead o itsel. The legal and policy ramework

in place, in addition to the temperament o the

electorate, will automatically narrow the pool o possible

partnership options. Most public sector entities ace

restricted choice in partnership arrangements.

Recently, several governments have improved upon

their existing PPP legislation. The State o Caliornia

has adopted a new legal ramework or transportation

PPPs that authorises regional transportation agencies

and Caltrans to enter into an unlimited number o

PPPs through 2017, removing earlier restrictions on

the number and type o projects they may undertake.

The South Arican PPP guidelines, as issued by the PPP

unit in national treasury, have been similarly relaxed

post the credit crisis, permitting government to retain

higher levels o risk in order to make proposed projects

undable by private sector bidders.

In addition to legislative constraints, political actors

oten determine the extent or nature o private sector

involvement. For example, in Canada and elsewhere,

core services (such as teaching, health care and prison

guards) are distinguished rom non-core services (such

as janitorial services, ood services and transportation),

and the public sector generally retains the ormer. In

the South Arican context, the resistance o trade union

bodies to perceived privatisation o essential services is

well documented. In addition, concerns have been raised

around the possibility o privatising Eskoms generating

capacity, which is seen as a strategic national asset.

Step 2: Defne project needs and objectives - What

do you want to do?

Once a public sector entity has determined what it is

permitted to do, the next step is to dene the project

goals. First, dene the need. For example, it could be

decongesting a certain corridor by 15 percent over the

next three years. The next step is to dene the service

solution and associated assets to meet that need. In this

case, the solution might be to deliver a new toll road

with specic capacity within a specied time period.

Lastly,policymakersmustdeterminehowthesolution

will be delivered and unded. Can tolls or congestion

charges be introduced, or must public unds rom

general (or special) taxation be made available?

Four o the most common variables that governments

should consider when dening the need that must be

ullled are speed, eciency, degree o certainty about

needs and innovation.

Step 3: Determine the best owner or each projectcomponent - Who can and should do what?

Determining what you have authority to do and then

what you want to do will begin to narrow the options

or structuring the relationship with the private sector.

The next step is sorting out who can and should

do what. The sorting process has three principal

components: capabilities, nance and risk.

Capabilities - What capabilities do we have in-house

to deliver and/or manage the project?

In what areas o project delivery does the public

sector project sponsor excel: design, operations,maintenance or nancing? What capabilities are

present in the market? For example, i a government

excels at road maintenance but is weak in

construction (cost or timing), it might decide to bear

responsibility or long-term asset condition, but allow

a private partner to add value at the ront end o

theproject.Thesamegoesformanagement.Large

capital projects are complex and require a great deal

o experience to manage successully. Partnerships

add another layer o complexity, and institutional

capacity building must be a core element o any PPP

programme. Eective project management is essential

to limit risk and cost overruns and streamline delivery,

so the presence o competent sta is o particular

importance when unding is tight.


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Financial - How are we going to pay or the

inrastructure?

An important, but oten conused distinction to

draw when considering the nancial elements o an

inrastructure project, is that between unding and

nancing. The unding or a project is its long-term

source o support. In the case o public inrastructure,

this may be revenues generated by the project,

dedicated tax revenues or general resources o the

sponsoring public sector entity. The nancing o a

project is the means by which the unding is leveraged

to provide enough upront cash to purchase, construct

or adapt the project. While there may be many

creative nancing vehicles available, once the unding

structure is established, all o these nancing vehicles

will be securitising the same project economics.

In the current tight monetary environment,

partnership structures may prove appealing or many

public sector entities. They may consider partnership

structures that reduce the public sectors capitalpayments over the lietime o the asset (or contract),

monetising existing assets to pay or new ones (or

example, Eskom could sell one o its existing operating

power stations, or example, Majuba, to raise cash to

und the construction o Kusile) or allow or nancing

by the private sector that does not eat into public debt

capacity. Using PPPs to raise private capital or public

projects can help to spur job creation when projects

would otherwise be put on hold.

Risk transer - How much risk should be transerred?

Answering this question correctly and allocatingrisks accordingly maximises public value. There are

several risk allocation conventions, or example, a

private contractor is naturally positioned to eciently

manage construction risks, and a government is

better positioned to control and absorb regulatory

risk. However, every partnership is unique and

careully negotiated.

As partnership models prolierate around the world,

risk allocation principals are becoming increasingly

sophisticated and the parties are becoming more

adept at crating structural solutions to risk capacity

constraints. For example, many PPPs have been

structured to isolate discrete and identiable chunks

o risk (such as tunnelling) to avoid contaminating the

overall risk-sharing approach with inecient pricing.

The public sector has discovered ecient ways to

write down those elements and still achieve value.

The key is to optimise, rather than maximise, the level

o risk transer.

One o the core tools being used in international

PPPsisthePublicSectorComparatororValuefor

Money analysis. The term Public Sector Comparator

(PSC) reers to the risk-adjusted whole-o-lie cost

o procuring an asset or service through whatever

is considered the conventional public procurement

method.ThetermValueforMoney(VFM)refersto

the result o a comparison between the PSC andthe risk-adjusted whole-o-lie cost o procuring

the same asset or service rom a private party. The

PSC/VFManalysisisusedtodescribethedifference

in risk-adjusted cost to the public sector between

conventional procurement and PPP procurement. In a

direct comparison, whichever model produces a lower

cost is said to provide value or money.

The practice in many countries is to perorm

this analysis as part o the approval process or

undertaking a project as a PPP. In those cases, unless

VFMcanbeproven,theprojectiseitherabortedor pursued by conventional procurement means.

The South Arican Municipal Services Act provides

or a similar comparison to be perormed by any

municipality wishing to outsource any aspect o

service delivery. The act requires the municipality to

rst calculate the cost and capacity o providing the

service in-house, to provide a benchmark against

which to compare the proposed costing or any

outside service provider to provide the same service.


11/12

In these challenging times, governments are coping with

the normal course o scal stress overlaid with a new

set o extraordinary demands on their resources. At the

same time, it is clear that reverting to a deault setting o

earlier times - putting inrastructure investment on hold

until the economy has recovered - will put economies

in an ever more precarious position going orward.

I inrastructure gaps are to be narrowed, the public

sector must respond with creative and fexible solutions

that evolve with the changing environment. Too oten,

public sector entities are unaware o the alternativesavailable to them or o the considerations involved in

selecting the most appropriate delivery models or their

capital projects. By applying a bottom-up approach to

the development o a partnership structure, the public

sector can deliver projects in a way that most closely

approximates the optimal solution within the connes o

what is possible.

Conclusion

Contact

Andr Pottas

Partner

Tel: 031 560 7033

E-mail: [email protected]

Reerences

1 Top Executives Say Current Inrastructure Investment Wont Support Business Growth, Says KPMG

Study, PRNewswire, January 14, 2009

.

2 Building Americas Future, Building Americas Future Releases New Poll: Majority o Americans Ready

to Pay or Better Inrastructure but Demand Accountability, press release issued on January 8, 2009

.

3 American Society o Civil Engineers, 2009 Report Card or Americas Inrastructure, January 2009.

4 Federal Highway Administration, US Department o Transportation, USDOT Approves $603 Million

LoantoBuildNewExpressLanesInFlorida:SunshineStateLandsNationsFirstTIFIALoanof2009,

March 4, 2009

.


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infrastructure finance - the changing landscape in sa

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